Why is the euro so strong, when the eurozone’s economy is barely out of recession?
This question puzzles experts and unnerves the area’s political and business leaders.
Since September, the euro has increased its value by more than 4%, to $1.37 yesterday from $1.31. Two separate factors underlie the current, toxic mismatch between the strength of the euro and the weakness of the European economy, and both are related to dysfunctional institutions.
The first is Germany’s Bundesbank, whose ideological approach to monetary policy keeps getting in the way of recovery. Chancellor Angela Merkel has considerable leverage to influence the bank’s behaviour if she wants to use it.
She could start by making sure she doesn’t promote another Bundesbank ideologue in the mould of the central bank’s president, Jens Weidmann, to replace Joerg Asmussen, the German member of the ECB’s six- member executive board who resigned on Monday.
The euro area is suffering from a disinflation problem that is widely perceived to be one external shock away from outright deflation.
Even so, markets are convinced that after cutting interest rates by a quarter of a percentage point in November, to 0.25%, the German members of the ECB council and their allies will constrain the governing board from further monetary accommodation.
The suspicion that the ECB won’t be able to use its remaining monetary policy tools, or add new ones, is contributing to the euro’s rise. Ironically, by boosting the euro, the efforts of Weidmann and his backers on the ECB board to prevent the November interest-rate cut set the stage for further monetary accommodation down the line — once the resolve of German industry and the Bundesbank have been sufficiently worn down.
Remember, even as the euro is up against the dollar, it has increased 10% against the yen in the past three months alone. The Japanese central bank has pumped huge sums into the monetary system, a move that Europe has been unable to make because of ECB rules, and Germany’s opposition to changing them.
This leap in the exchange rate hurts euro-area exports.
The October figures for eurozone industrial production published last week show a 1.1% decline compared with September, and a 0.2% increase for the year.
The Bundesbank doesn’t seem to understand that it is far better for the ECB to do the monetary accommodation before damage occurs, than afterwards. Hypocrisy is also contributing to fraying European solidarity.
The Bundesbank tirelessly lectures countries such as Italy and Spain on how important it is that they get their costs down, so they can become more globally competitive. At the same time, however, the German central bank is making that task even harder, by enabling the euro’s rise.
Whatever suffering the surging euro causes German manufacturers, it is small change compared to the damage inflicted on Europe’s poorer countries.
The second reason for the euro’s artificial strength is the dysfunctional US government. Months of congressional deadlock over the budget have distorted the policy mix such that monetary policy has had to provide all the stimulus the still-flagging economy needs, while fiscal policy has been neutralised.
One consequence is that US interest rates are lower than would have been the case if Congress and US president Barack Obama’s administration been able to forge more than a bare- boned fiscal deal. This has helped put the euro on steroids. There have been suggestions the Federal Reserve’s decision to taper its securities purchases will help bring the euro down, but I doubt it.
The political paralysis in Washington is causing economic distress in Europe. Unfortunately, there is precious little Europe’s leaders can do to correct the problem. But Merkel can, by isolating Weidmann and letting markets know she supports ECB policy.
* Melvyn Krauss is an emeritus professor of economics at New York University and senior fellow at the Hoover Institution, Stanford University
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